Abstract
The paper reviews the recent literature on tax reform, and recommends abolishing the profits tax and treating personal incomes from all sources as taxable, including capital gains and dividends. Abolition of the profits tax will vastly improve the investment environment and eliminate wasteful distortions. We also offer an intermediate “gradualist” approach involving halving the profit tax rate and taxing half of dividends and capital gains. We augmented a model proposed by Chetty and Saez [1] to incorporate the effects of manager effort for investment and showed the strong adverse effect of the profit tax on investment. Given that successive increments in total personal incomes from all sources are typically characterized by increasing intensity in economic rent, a progressive tax structure with high marginal tax rates at the top and wide tax bands is not only more equitable, but can be justified on efficiency grounds.
Highlights
In a recent article in Financial Times, Lawrence Summers (2012) [2] raised concerns over how to raise revenue, fairness, avoiding excessive complexity, and the adverse effects of such complex tax rules on the economy.1 As events unfold showing the prevalence of tax inversion and tax avoidance amid a dearth of investment and discontent over the rising inequality, the need for a simpler, fairer, and more pro-growth tax system has become apparent.In a highly globalized environment, with tax arbitrage, tax havens, and developments in information technol-How to cite this paper: Ho, L.S. and Zhang, T.L. (2016) Tax Reform for a Fairer, More Vibrant Economy
The corporate profit tax has long been known as an important consideration for firms’ locational decisions. 5Devereaux [4] concluded from his survey of empirical works and his own analysis that the effective average tax rates tend to play a significant role in discrete location choices, even though the effects of marginal tax rates are rather minor
The tax rate on long-term gains was reduced in 1997 from 28% to 20% and further from 20% to 15% in 2003. For those whose effective marginal tax rate is less than 15%, the tax rate on capital gains was cut from 10% to 5%
Summary
In a recent article in Financial Times, Lawrence Summers (2012) [2] raised concerns over how to raise revenue, fairness, avoiding excessive complexity, and the adverse effects of such complex tax rules on the economy. As events unfold showing the prevalence of tax inversion and tax avoidance amid a dearth of investment and discontent over the rising inequality, the need for a simpler, fairer, and more pro-growth tax system has become apparent. Some evidence to this effect is presented. From this observation it is suggested that raising the top marginal tax rates need not affect incentives on effort, provided that they apply to increases in income that are on top of already very high incomes.
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